What next for Deutsche Börse and NYSE Euronext?

With the prospective merger between Deutsche Börse and NYSE Euronext teetering on the brink of collapse, the two exchanges may have to rethink their strategies and take a slower approach towards consolidation.

With the prospective merger
between Deutsche Börse and NYSE Euronext teetering on the brink of collapse,
the two exchanges may have to rethink their strategies and take a slower
approach towards consolidation.

The DB/NYSE deal was
initially announced around a year ago but is now close to being terminated
following press reports claiming that Joaquin Almunia, the European
commissioner leading the antitrust probe, has recommended blocking the deal in
a draft report that is currently circulating in Brussels.

While ominous, the rejection
is far from formalised with a further round of intense lobbying expected prior
to the European Commission’s official 9 February decision deadline.

The main criticism of the
deal is its potential to create a monopoly in European exchange-traded
derivatives. The reports suggest that the divesture of Eurex or Liffe, the derivatives
exchanges owned by Deutsche Börse and NYSE Euronext respectively, would be the
only way the European Commission would give its blessing to the deal.

However, the chances of the
exchanges selling off their derivatives units are slim, as their combination
has often been cited as the main rationale for the deal by the exchanges’
executives. The bourses have already made a series of concessions designed to
allay monopolistic fears.

With 2011 being remembered
by many as the year of numerous failed exchange mergers, where can the
exchanges go from here?

Strategic alliances

Partnerships between exchanges are growing in number – particularly
between those in developed and emerging markets – and are a less regulatory
intensive means of growing revenues. Eurex already has a partnership with the
Korea Exchange, reporting strong volumes in the KOSPI futures contract last
year. NYSE Euronext launched a cross-market access solution with the Tokyo
Stock Exchange last December. Increasing these types of arrangements opens up
new markets for bourses to explore.

“I don't think there is a need for either Deutsche Börse or NYSE
Euronext to hurry and look for new merger opportunities and I think exchange
consolidation will happen in smaller increments in the future,” Niki
Beattie, managing director at consutancy market Structure Partners, told
theTRADEnews.com. “We may see more strategic partnerships in the short-term
that allow markets to develop trust and to demonstrate capabilities
in certain areas before committing to consolidation.”

A couple of examples from recent years include the CME Group’s link with Brazil’s
BM&F Bovespa, which initially started as a cross-listing arrangement and
later resulted in each taking a 5% stake in the other’s company. The partnership
also resulted in a new US$200 million trading platform at BM&F Bovespa,
based on existing CME Group technology. Furthermore, the Mercado Integrado
Latino Americano, an alliance that links markets in Chile, Colombia and Peru,
was established last year and could grow further if Mexican joins this year.

It could be argued that this approach for greater geographical diversity would benefit Deutsche Börse the most, given that its business already covers
European equity and derivatives trading and clearing via Xetra and Eurex,
settlement and custody via its Clearstream subsidiary, and market data and
indices via its STOXX business.

Banking on regulation?

The next few years will also
see a raft of new legislative measures that could either stimulate or hinder exchange
revenue growth.

Opportunities

The European markets
infrastructure regulation (EMIR) and the US’s Dodd-Frank Act include proposals
to standardise OTC derivatives so that they can be traded on exchange and
centrally cleared. With the detail of the new rules due to be finalised in the
coming months, exchanges have been looking for ways to tap into a market that
was worth US$708 trillion in the first half of 2011.

Capital constraints imposed
by Basel III also offers opportunities for exchanges to fill the gap left by
banks that may have to exit certain capital-intensive activities.

“The ability of banks to
stump up risk capital will be reduced under new regulations, which offers
exchanges the opportunity to try and facilitate these types of models without
disintermediating their customers,” said Hirander Misra, former COO of
multilateral trading facility Chi-X Europe and founder of consultancy Misra
Ventures. “This is likely to be focused on hybrid quote-driven trading models
with reporting and clearing functions, as opposed to order book models.”

Misra is currently working
with UK market operator PLUS Markets Group on the development of PLUS-TS, the
firm’s new trading technology unit.

EMIR along with MiFIR, a
new regulation that will accompany MiFID II, could compel exchanges to open up
both equities and listed derivatives clearing facilities to competitors. This
would attract revenues to the largest clearing houses, such as Eurex Clearing,
as market participants seek to reduce costs through margin offset arrangements,
although this is not guranteed. Access to Eurex Clearing was part of the
remedies offered to regulators as part of efforts to get the deal passed.

Threats

However, what regulation gives with one hand could be taken away with
the other, if open access provisions to benchmark indices are upheld.

This could force Deutsche Börse to allow competitors to base products
based on the hugely popular EURO STOXX 50 index, which would ultimately reduce
its income

Furthermore, Misra points out that a year of – what appears to be futile
– lobbying would have incurred opportunity costs. While DB/NYSE have spent a
tremendous amount of time trying to convince stakeholders of the industry logic
of their combination, other exchange groups and financial institutions have
been busy planning for the opportunities related to new regulation.

One of the main motivations for the DB/NYSE deal was its potential to
offset the domestic bourses falling equity market share following the
elimination of the concentration rule through MiFID in 2007. With the two
largest multilateral trading facilities, BATS Europe and Chi-X Europe, recently
completing a merger that gives them a combined market share of over 25% – the
largest in Europe – local stock exchanges could fall further behind. BATS Chi-X Europe have also moved ahead of domestic exchanges in equity clearing, offering members the ability to cut post-trade costs with four-way interoperability.

The London Stock Exchange (LSE) has also made up ground after making a
slow start post-MiFID. Within the last two years, the LSE has bought Sri
Lanka-based trading technology firm MillenniumIT, launched equity derivatives
trading on its own Turquoise MTF and is currently locked in discussion with
clearer LCH.Clearnet, which would give it a further opportunity to diversify
its revenues.